Explaining the $25B mortgage deal....

[Moonbox]

From what I've read 90% or more of you have no idea what they're talking about with the $25B CMHC deal that just took place and you somehow think that it's a bailout akin to what happened in the US.

Somehow a lot of you think that the deal proves that this proves the IMF etc are full of crap when they said Canada's banks are the strongest in then world.

Let me briefly explain how this deal works to you.

CMHC, first, is a crown corporation that provides the vast majority of mortgage default insurance to Canadian banks for people with high-ratio (over 80% financed) mortgages. If a high-ratio mortgage defaults, CMHC pays the amount owing.

CMHC has purchased $25 Billion worth of the lowest risk, best performing mortgages in Canada, in order to free up cash for the banks so they can continue to lend cheaply without having to jack interest rates way up and make loans harder to get.

Why did they have to do that? Because there is not enough liquidity in worldwide financial markets for the banks to finance their lending operations as cheaply as they have previously been able to.

Without this plan, banks would have to get stingey with their lending and make mortgages, loans and lines of credit harder and more expensive to get. This would have caused the economy to slow.

This was an infusion of cash that will ultimately cost the tax payers nothing and will likely end up making the government money. The banks were willing to take the deal because they'll be able to make more profit on the new money they will be lending out than they would have with the mortgages they sold with low interest rate spreads. The banks have all raised their rates recently despite the central bank lowering interest rates. You can't get a below-prime mortgage ANYWHERE in Canada anymore and new secured lines of credit will cost people a full 1% more in interest than they did a week ago. If CMHC hadn't purchased the mortgages, the rates would be even higher.

The difference between this deal and the 'bailout' in the US is that first it was not a straight out purchase or 'nationalization' of our banking industry. Rather than basically take over the banks, CMHC bought out some of the banks' well-performing investments.

Not only that, this deal was meant to be an infusion of cash to help nudge the economy forward and soften a slowdown. In the US it was a full-on bailout to prevent the collapse of the banking industry at large, which isn't even conceivable right now in Canada

Edited October 12, 2008 by Moonbox

[Slim MacSquinty]

Just a slight correction, CMHC is for financing when one doesn't not have sufficient downpayment for a conventional mortgage which means 75% financing. I also thought that Flaherty said it was not a cash purchase of the paper, but an exchange for bonds, which of course would be significantly more liquid for the banks to deal with on an as cash basis.

[Moonbox]

Just a slight correction, CMHC is for financing when one doesn't not have sufficient downpayment for a conventional mortgage which means 75% financing.

No what I said was right. CMHC doesn't finance mortgages at all. The banks do that. Selling mortgages is part of my job but I won't begrudge you that. You're sort of right in that CMHC provides default insurance for people who don't have enough downpayment for a conventional mortgage. Conventional nowadays is also 80% or below now. It used to be 75%.

Anyways over 80% financing is considered a risky mortgage and the banks are basically required by law banks to purchase default insurance on any mortgage financing over 80%. The client pays a default insurance premium for every % point they finance over 80% and if the mortgage goes bad CMHC pays the money back to the bank. There are private companies that do the same thing but most high-ratio mortgages in Canada are insured by CMHC

I also thought that Flaherty said it was not a cash purchase of the paper, but an exchange for bonds, which of course would be significantly more liquid for the banks to deal with on an as cash basis.

This part is a little fuzzy for me. What I understood from the deal was that Flaherty is selling bonds and the proceeds of the bonds will purchase the mortgage deals. The proceeds from the mortgage deals will pay off the bond amounts owing so unless all of these mortgages go bad then the government will make good money from this. CMHC has cash on hand to pay off any of these bad mortgages anyways as that's it's purpose in the first place.